Fundamental Stupidity Led To Financial Crisis, Davos

The forum included people from various disciplines ranging from university professors to entrepreneurs. The participants were 40 percent from Europe and despite the fact that the developing countries suffer equally much from this global financial and economic crisis in terms of less remittance and less tourism there were fewer participation and presence from the developing countries.

The forum's topic was What Happened To The Global Economy and what led to this crisis.

I was taking notes as I was watching the live webcast of the discussion, which was quit interesting and amusing, but my general understanding was that taking too much risk, lack of proper oversight and faith in market efficiency (what they teach business and MBA students) have led to this financial mess and we got what we deserved.

Over the course of the years the economists and the financial analysts had developed modules and and systems to lead the developments. The banks took huge amounts of risks helped by those bogus modules. The banking risks were helped by The Basel Committee on Banking Supervision, who sets the rules governing banking industry. The banks had put themselves in such a vulnerable position that they had gone down under-water drugging the economy.

We were led to believe that the house prices couldn't go down. They have been going up for years and years and we put too much faith in the real estate. However, we saw that the house prices can actually go down and can go down substantially. In the year 2008 the house prices went down 18.2 percent, slicing at a record pace.

Big Moral Problem: Greed is NOT good

The forum had a good amount of discussion about the lack of moral compass and ethics that reigns in the financial industry. Indeed, greed is not good, and morals should govern our daily lives and businesses.

The businesses and the society had lost the moral compass and we have put a lot of reliance on regulations and the mathematical models to run the economy and the financial markets. We wrongly thought regulations, modules and systems would replace the moral compass and ethics. We were wrong.

The capital activity had gotten so far out of the way of the real economy and there was so much invention going on that we lost track of things.

Contrary to teaching, markets may not adjust efficiently.

There were obviously many mistakes made, but the main mistakes are our assumptions about markets and economy.

One major mistake on our part, still widely held today, is the belief that markets adjust efficiently to their mistakes. Apparently they are not. We are afraid that the stabilization may not come and we bailout the banks and major financial institutions. However, this has led to several problems and one of them is the following. The financial markets have stabilized, but banks are not lending.

We cannot heal the economy if the banks and lending institutions are either slow or not lending. But we gave the taxpayers' money to them and bailed them out so they can lend. What happened?

Regulatory Mistakes

Regulatory mistake was to put too much faith in the banks, markets and efficiency. The policy makers need to make it clear that there are serious consequences for inappropriate failures. The policy makers need to show the people that those who are responsible for this crisis are held accountable. We either need more accountability or more oversight. Otherwise we pay dearly for those mistakes and failures.

As a result of this financial crisis the ILO today announced that 50 million people will be unemployed in the months to come.

At the end of the discussion the participants voted on the topics of discussion. The participants first agreed that we held the following beliefs that proof not to be working well.

1. Markets regulate efficiently
2. Cheap money financing
3. Good times last forever
4. Puting regulation over ethics
5. We believed in high leverage
6. China can do our saving

The voting showed that the assumption that is most widely held today is the Self regulation of the markets. 50.7 percent of the voters think this is the assumption that is held most widely. But this is only an assumption and not necessarily true, proves today's financial and economic mess.

Bartiromo raised the question of which regulatory failures proved to largest systemic shock. Which should the G20 look at, which regulatory failure should be the top priority for G20 countries.

Those who answered said that we have a lack of international regulatory framework and need to focus to develop and international regulation. No matter who drills the hole everyone is going down.

The participants also discussed the market failures that risk the greatest public backlash.

Misalignment in performance risks public backlash. We have seen this so far in Latvia and Iceland.

The public outraged about the failures. Some think it may take a public and private apology, some think the guilty fined and going to jail is what it will take to get the people satisfied.

No matter what measures we take it is very important to show that this is not and cannot be repeated.

Economic downturns and crises have happened in the past and keep repeating. The only way it can't be repeated is to have punishment. People who sent those risky products should give the money back.

Some executives racketed a lot money and the taxpayers are paying for that. Unless you have a fair punishment system you will never be immune from risks and abuses of any sort.

In fact one participant said "may be some of the people here are those who have to return money."

In finding cures to the economy the participants stressed the need to be more specific. The general approach may not help, but what will help is to look at the specific failures that led to this point and to address them.

We need to democratize the finances. The question is how to make the financial institutions to really work for people, but not result in 1 million mortgage foreclosures end huge amounts of job loss.